Question

In: Statistics and Probability

   Consider a principal-agent problem with three exogenous states of nature, θ_1,,θ_2,θ_3, two effort levels, e_L...

   Consider a principal-agent problem with three exogenous states of nature, θ_1,,θ_2,θ_3, two effort levels, e_L and e_H and two output levels, distributed as follows as a function of the state of nature and the effort level:
State of Nature   θ_1   θ_2   θ_3
Probability   1/4   1/2   1/4
Output under e_H   18   18   1
Output under e_L   18   1   1
The principal is risk neutral, while the agent has utility function u(w)=w^(1/2). when receiving monetary compensation w, minus the cost of effort, which is normalized to 0 for e_L and to 0.1 for e_H. The agent’s reservation expected utility is 0.1.
   Derive the first-best contract.

   Derive the second-best contract when only output levels are observable.

   Assume the principal can buy for a price 0.1 an information system that allows the parties to verify whether state of nature θ_3 happened or not. Will the principal buy this information system? Discuss.

Solutions

Expert Solution

orchestra answered 3 years ago
Next > < Previous

Related Solutions

Opportunistic and overoptimistic behavior transforms the principal-agent relationship between investor and entrepreneur into a principal-agent problem.’...
Opportunistic and overoptimistic behavior transforms the principal-agent relationship between investor and entrepreneur into a principal-agent problem.’ Explain why the above statement is true and outline the mechanisms which are available to both parties to reduce this problem.
What is the principal-agent problem? What are three ways in which firms try to cope with it?
 What is the principal-agent problem? What are three ways in which firms try to cope with it? The principal-agent problem is the problem of A. devising compensation rules that induce an agent to act in the best interest of a principal B. the principal stock owner of a firm finding an agent at the NYSE who will manage his account C. the agent setting prices that will benefit the principal D. communicating the principal's wishes to the agent Three ways of attempting to cope with the principal-agent...
Explain the principal-agent problem as it pertains to equity contracts.
Explain the principal-agent problem as it pertains to equity contracts.
5. Explain the Principal-Agent problem in private enterprises. Cite an example or two to show the...
5. Explain the Principal-Agent problem in private enterprises. Cite an example or two to show the seriousness of the problem in even some of the biggest North American businesses. How does a Japanese CEO differ from his North American counterpart?
The two general ways of addressing the Principal-Agent problem are Prosecution and Conviction Alignment and Oversight...
The two general ways of addressing the Principal-Agent problem are Prosecution and Conviction Alignment and Oversight Treasury and the Federal Reserve Accounting and Auditing
What does the principal agent problem refer to, and what is an example of it? In...
What does the principal agent problem refer to, and what is an example of it? In your example, what is something that the agent might do that would con flict with the goals of the principal? What actions could the principal take to try to prevent (or at l east reduce) this problem
A principal has different options of setting wages and the Agent has different levels of work....
A principal has different options of setting wages and the Agent has different levels of work. Consider this model with the following special values: u(2√w); dH=15, dL=0, g=300, m=200, b=100, wb=wage base=0 eH results in a probability of profit levels g, m, b as 0.5, 0.3, 0.2 eL results in a probability of profit levels g, m, b as 0.2, 0.3, 0.5 Assuming the Principal chooses a pure wage scheme, what would be the expected payoffs for the Principal and...
A principal-agent problem can arise when an insurance agent sells a policy to a buyer who...
A principal-agent problem can arise when an insurance agent sells a policy to a buyer who uses it as an incentive to behave badly. a principal hires an agent to do something on their behalf, but the principal cannot perfectly observe the agent's actions. an agent hires a principal to do something on their behalf, and the agent can observe the principal's actions. a principal uses an agent to accomplish a task the principal wants credit for completing. Which of...
The following payoff table shows the profit for a decision problem with two states of nature...
The following payoff table shows the profit for a decision problem with two states of nature and two decision alternatives: State of Nature Decision Alternative s1 s2 d1 10 1 d2 7 3 (a) Suppose P(s1)=0.2 and P(s2)=0.8. What is the best decision using the expected value approach? Round your answer in one decimal place. The best decision is decision alternative (- Select your answer -d1 /d2) with an expected value of. (b) Perform sensitivity analysis on the payoffs for...
The following payoff table shows the profit for a decision problem with two states of nature...
The following payoff table shows the profit for a decision problem with two states of nature and two decision alternatives: State of Nature Decision Alternative s 1 s 2 d 1 6 3 d 2 9 1 Use graphical sensitivity analysis to determine the range of probabilities of state of nature s 1 for which each of the decision alternatives has the largest expected value. If required, round your answers to two decimal places. d1 is optimal for probability of...
ADVERTISEMENT
Subjects
ADVERTISEMENT
Latest Questions
ADVERTISEMENT